Bobby’s New Clothes Part 3

Well now here we are then. The worst EVER first 5 trading days of a year in the history of the Dow. And the S&P 500. And the FTSE. And the CAC and the DAX. You know, big ones, the big hallmark indices of each country, not some newcomer like that Shanghai Composite:

First 5 days

Now, the start of a year shouldn’t mean anything in and of itself. It’s not even the start of a new year if you’re Chinese, so calendrical delineation should not lead us astray. But markets are made of people, and people see headlines, and people call their brokers and say “Sell Mortimer Sell, get me out of at least some of this, just in caseSELL mortimer

Over the weekend it was thought the dust might have settled. China, sure it has issues, but should the rest of us care? Well, it started with this, the overnight interest rate for the Chinese yuan trading in Hong Kong (the CNH, the allegedly more accessible way to trade Chinese yuan) – spiking up to almost 14%:


This basically makes it much more expensive to hold a short CNH position. Is this the Chinese trying to burn speculators against their currency, or just a natural market response to the failure to deliver an anticipated cut to interest rates over the weekend?

Then we got another flash crash in the South African rand on the open:

USDZAR 11 Jan 2016

Just take note of the scale on this chart – USD/ZAR went from 16.50 to almost 18.00 in a matter of minutes. This would be remarkable, were it not almost exactly what happened on August 24th. This flash crash was worse in percentage terms, and is allegedly linked to ZAR/JPY stops going off due to retail brokers increasing their margins on trades. It doesn’t matter what caused it, the most important point to note here is that it happened. And the mirroring of the events of August 24th is instructive – this was the last period where volatility went crazy and everyone panicked that it was the end of days. The S&P500 is yet to reach those lows from August, but evidently 1867 is becoming a ‘bit of a level’ in the market parlance – i.e. a break of that would see the panic headlines zoom off the charts.

Whoa there a minute…. this all feels rather unsettling because not much has really yet changed on the macro front. Sure, the Fed hiked, and sure, the US data has been softening, aside from that stellar jobs report on Friday. But it is still too early to tell if the nascent wage growth is enough to offset poor activity data and derail the Fed from a March hike. A hike for March is only 40% priced anyway (down from 50% last week). We are still in the same set-up as last August: Either the US economy can’t take the withdrawal of liquidity, or it can and is doing do because of renewed confidence over the underlying economy. SEPARATELY, Emerging Markets are in serious trouble if they are linked to commodities, which will continue to fall as global trade falls due to China’s domestic rebalancing.

So, Bobby’s dream is becoming a reality and the Emperor’s New Clothes are falling. As Mohammed El-Erian put it:

“Markets are realizing that central banks can no longer repress financial volatility. And they are repricing to new volatility paradigm….”What we’re going to see is every time something happens in the world it’s going to take longer to restore stability”

Amen to that.


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